The Myth of Fractional Reserve Banking and the Monetary Multiplier

“There is a yawning chasm of mutual misunderstanding, which has persisted for decades, between economists and those working in Central Banks. Virtually every monetary economist believes that the central bank can control the monetary base (M0), and, subject to errors in predicting the monetary multiplier, the broader monetary aggregates as well. Almost all who have worked in a Central Bank believe this view is totally mistaken” – Professor Charles Goodhart 1994

Cause or Effect : If you are a Martian and walk into one pub and see 10 beer mats on the bar and 20 customers, then go to another pub and see only 5 beer mats on the bar and only 10 customers you might report back to the Mother-Ship that the more beer mats a pub has, the more customers it gets, so if you double the beer mats you’ll double the customers. His ‘a priori’ academic maths is perfect and he could even go back to Mars and issue degrees to his University Students in how to run a pub on Earth and have questions with ‘right answers’ and graphs on the relationship between beer mats and customers – but unfortunately the Martian is ‘totally mistaken’ as to how things really work and if he tried to run a pub on Earth based on his theories he’d go out of business pretty quick.

Now try this : If you are one of those economists referred to by Professor Goodhart, or have been taught by one, and you look at the balance sheets below and try to explain how the Commercial banks managed to increase the size of their balance sheets by £11,000 while the Central Bank only increased it’s Balance Sheet by £1,000 between 2005 and 2006, then you might come up with one of the following ‘totally mistaken’ pieces of reasoning, or something essentially the same.

Balance Sheets :

  2005 2005   2006 2006
  Central Bank Commercial Banks   Central Bank Commercial Banks
Government Bonds 10,000     11,000  
Loans to Customers   100,000     110,000
Balance at Central Bank   10,000     11,000
Current Accounts   (110,000)     (121,000)
Inter Bank Deposits (10,000)     (11,000)  
Check 0 0   0 0

 Economist’s ‘totally mistaken’ explanation a) the ‘Monetary Multiplier’ 

The Central Bank ‘Increases the money supply’ by £1,000 by say buying £1,000 of Government Bonds. The Government uses this £1,000 to pay public workers who now have £1,000 extra in their Current Accounts with the Commercial Banks. This gets us to Stage 1 – 

  Central Bank Commercial Bank 1
Government Bonds 11,000  
Loans to Customers   100,000
Balance at Central Bank   11,000
Current Accounts   (111,000)
Inter Bank Deposits (11,000)  
Check 0 0

 As you can see at Stage 1, the Commercial Banks now have a balance at the Central Bank of £11,000 – i.e. the Bank of England owes them £11,000 – this is ‘Real’ Money, proper ‘Bank of England’ Money – ‘Sound Money’… so they say. The Commercial Banks are happy to lend out 10 times (10 being an arbitrary value for the ‘Monetary Multiplier’ I’ve chosen for this example) ‘more than they have’ – i.e. more than the ‘real money’ they have – ‘real money’ being what the Bank of England owes them. So then the Commercial Banks are happy to issue new loans to customers to the value of £1,000 x 10 = £10,000. The Bookkeeping being : Dr 10,000 Loan Accounts Cr 10,000 Current Accounts and in this way we arrive at the final balance sheet, when the new ratio of “Customers to Beer Mats” – oh sorry “Loans to Balances at the Bank of England” is once again at 10 (11,000/1,100 = 10) QED ! Usually however this story is embellished with several Commercial Banks, each one keeping an amount equal to the ‘Required Reserve’ ratio and ‘loaning out the rest. Starting from scratch it looks like this – Economist’s ‘totally mistaken’ explanation b) ‘Fractional Reserve’. Stage 1 The Central Bank buys a Government bond for £1,000 and the Government pays the £1,000 to say public workers who deposit their pay cheques in the Commercial Banks so we then have this : 

  Central Bank Commercial Bank 1
Government Bonds 1,000 0
Loans to Customers 0 0
Balance at Central Bank 0 1,000
Current Accounts 0 (1,000)
Inter Bank Deposits (1,000) 0
Check 0 0

 Stage 2 Bank 1 keeps the ‘Required Reserve’ (10% in this example so £1,000×10%=£100) and ‘loans out the rest’ – which ends up being deposited in another Bank – Bank 2. So we now have : 

  Central Bank Bank 1 Bank 2
Government Bonds 1,000 0 0
Loans to Customers 0 900 0
Balance at Central Bank 0 100 900
Current Accounts 0 (1,000) (900)
Inter Bank Deposits (1,000) 0 0
Check 0 0 0

 This new loan of £900 has also created a new Current account of £900 and a new current account of £900 is new money. So we started off with £1,000 of New Money and we now have £1,900 of New Money – This is called ‘Fractional Reserve’ Banking. But it does not stop there, the process continues :

Stage 3 Bank 2 keeps 10% (£900×10%)=£90 – and ‘loans out the rest’

  Central Bank Bank 1 Bank 2 Bank 3
Government Bonds 1,000 0 0 0
Loans to Customers 0 900 810 0
Balance at Central Bank 0 100 90 810
Current Accounts 0 (1,000) (900) (810)
Inter Bank Deposits (1,000) 0 0 0
Check 0 0 0 0

 This new loan of £810 has created yet another new Current Account of £810 – more new money ! So we started off with £1,000 of New Money and we now have £1,000 + £900+ £810 = £2,710 of new money. This process goes on and on so that the new money created ends up as £1,000 + £900 + £810 + £729 + …. + 1 = £10,000 (in O Level Maths speak this is the sum of a Geometric progression, the answer being given by the formula a/(1-r). With a=1,000 and r=0.9 we have :1,000/(1-0.9) = £1,000/(0.1) = £10,000 Again by a bit of O Level maths, the grandly named ‘Monetary Multiplier’ turns out to be just 1/(‘Required Reserve’ Percentage). So with a ‘Required Reserve’ percentage of 10%, the ‘Monetary Multiplier’ is 1/0.1 = 10. So with the original New Money being £1,000 we have Original New Money X ‘Monetary Multiplier’ = Total New money Created : £1,000 X 10 = £10,000 Had the ‘Required Reserve’ Percentage been 20%, the ‘Monetary Multiplier’ would have been 1/0.2 = 5 and so only £5,000 of new money would have been created from the original £1,000 : £1,000 x 5 = £5,000. These two explanations, which very impressively come to the same answer (impressive to those whose maths is a bit weak – which includes most economists), do not actually show how banks really work – they just show how a Geometric Progressions works. It’s little more that having a question like “If two apples and three oranges cost £1.50 and five apples and two oranges cost £2.30 how much does one apple cost ?”, getting the right answer then going to the shop expecting the price of an apple to be the same as the answer in the back of the text book. All the apples problem tells us is how to solve equations, all the fractional reserve routine above tells us is that you can add up a Geometric Progression the long way round £1,000 + £900 + £810 + £729 + …. or the short way round : £1,000 X ‘Monetary Multiplier’ – it’s just a maths exercise it’s not what actually happens in reality (Wikipedia has a similar explanation : Fractional Reserve Banking , as does this You Tube Video recommended to me by an Austrian School Economist, a similar misunderstanding is found in Money Masters Video Video)

Real Banking : Starting with this, as before :

 

  Central Bank Commercial Banks
Government Bonds 10,000  
Loans to Customers   100,000
Balance at Central Bank   10,000
Current Accounts   (110,000)
Inter Bank Deposits (10,000)  
Check 0 0

 Stage One : The driver is not the Central Bank buying bonds it’s the customers of the Commercial banks requesting loans for various purposes. So the real life stage one is actually this : 

  Central Bank Commercial Banks
Government Bonds 10,000  
Loans to Customers   110,000
Balance at Central Banks   10,000
Current Accounts   (120,000)
Inter Bank Deposits (10,000)  
Check 0 0

 Here the first thing that happened was the Commercial Bank issued new loans to its customers for £10,000

Stage Two : The Commercial Bank buys a government bond for £1,000 and sells it to the Bank of England for £1,000 to get the ‘Required Reserve’ ratio back in line again – that’s it ! That’s all there is to it ! – “In addition, standing deposit and (secured) facilities are available on demand, in unlimited amounts, to a wide range of banks and building societies.” http://www.bankofengland.co.uk/publications/news/2006/055.htm – The Bank of England will buy Unlimited quantities of, it used to be Government bonds and/or  Government bond backed repos but now it’ll take a range of securities… at the official interest rate – which isn’t very high so it’s in the interest of the commercial banks to only sell the bare minimum to the Central bank to get enough ‘cash’ from the Central Bank to cover their reserve requirements – a loose change “tidy up” after doing as much “real business” i.e. issuing as many loans as their reliable customers ask them for – a Central Bank Reserve is a tail and it does not wag the business dog .

And of course a bank, being a bank and different from me or you, does not need ‘cash’ to buy such a bond ! – Well when a normal individual buys something they have to hand over cash or go in to debt. A bank just goes into debt and… Bank debt is cash : Debit : Government Bonds £1,000, Credit Current Account of person who sold the bond to them on the open market £1,000 – it’s a funny world in the banking sector !

Rather than the ‘Reserve’ at the Central Bank being the ‘Base and Driver of the Economy’ or some such other grand and solid sounding expression like that – its just an after-the-fact, loose change, slightly nusiancy balance that very simple to adjust.

Whoever sells the bank the £1,000 Government bond to the bank then has a Current Account with the bank of an extra £1,000. So we once again arrive at :

 

Central Bank Commercial Banks
Government Bonds 11,000  
Loans to Customers   110,000
Balance at Central Banks   11,000
Current Accounts   (121,000)
Inter Bank Deposits (11,000)  
Check 0 0

There are reasons why customers request loans and reasons why Banks agree to issue them or not – see The World through the Bank Manger’s eyes below. Ranking very low on the reason list is anything to do with the Central Bank. The balances at the Central Banks are just loose change, they earn zero or little interest and if banks have any concern with them it is to keep them as low as possible. What this shows is that, in the same way that the amount of beer mats in a bar is an effect of both the demand by customers for beer and of the beer mat policy of the pub Landlord, the amount of money held in reserve in the Bank of England is an effect of the demand for loans by customers of Commercial Banks and the policy of the Commercial Bank managers in meeting those demands. In other words, the ‘Cash and Balances at Central Banks’ accounts are just loose change from the transactions between Commercial Customers and Commercial Banks – they are not the driver – the base – of commercial activity – it’s just a tail and attempts to use it to wag the dog will leave you with an bar full of beer mats and no customers or in the present situation – lots of government debt being bought without ‘lots of Bank of England Balances’ X ‘The Multiplier’ increase in private commercial activity. The Story in the Martian Times “Beer Mat Surge isn’t Working ! The expected increase in customer numbers following the Beer mat Surge has failed to materialise puzzled experts warned today” is analogous to the Earth bound headline Quantitative Easing isn’t Working ! .

As a de-facto, below are a few lines from Barclays PLC balance sheet at the end of 2005. Prior to QE, this was a fairly is a fairly standard bank balance sheet. The cash at the central bank is nowhere near the 10% of the size of the Balance Sheet figure used above and in text books – it’s more like 0.5 % ! If you study hard and go to University, and work hard and spend little to pay off your student debt and work even harder and end up with £10,000 in your bank account before you are 30 or 40 and go for night out with friends and have £50 in your pocket, then that £50 is 0.5% of your financial wealth – 0.5% is a little bit more that loose change, nothing more.

 

  2005
Barclays Bank PLC £m
Cash and balances at central banks 3,506
Trading portfolio assets 155,730
Derivative financial instruments 136,823
Loans and advances to banks 31,105
Loans and advances to customers 268,896
Repos etc 160,398
Other assets 4,620
Goodwill 6,022

 Reductio ad adsurdum – Proof by Contradiction. Ok I’m going to get a little a priori myself here, to prove that fractional reserve banking is an academic myth : Lets look again at the detailed multi-Bank story of Fractional Reserve Banking in slow motion to see if we can spot the elephant in the room :

Stage 1 The Central Bank buys a Government bond for £1,000 and the Government pays the £1,000 to say public workers who deposit their pay cheques in the Commercial Banks so we again have this : 

  Central Bank Commercial Bank 1
Government Bonds 1,000  
Loans to Customers    
Balance at Central Bank   1,000
Current Accounts   (1,000)
Inter Bank Deposits (1,000)  
Check 0 0

Stage 2 (a) Bank 1 keeps the ‘Required Reserve’ (10% in this example so £1,000×10%=£100) and ‘loans out the rest’. So we now actually have :

  Central Bank Bank 1 Bank 2
Government Bonds 1,000    
Loans to Customers   900  
Balance at Central Bank   1,000  
Current Accounts   (1,900)  
Inter Bank Deposits (1,000)    
Check 0 0 0

 Stage 2 (b) The person who received the loan pays the £900 to someone else who banks at bank B – so we then have …:

 

  Central Bank Bank 1 Bank 2
Government Bonds 1,000    
Loans to Customers   900  
Balance at Central Bank   1,000  
Inter Bank Amounts Owed     900
Current Accounts   (1,900) (900)
Inter Bank Deposits (1,000)    
Check 0 0 0

 and the ‘Fractional Reserve’ story comes to a dead end ! Bank 2 has no Central Bank Reserves to lend out ! – it’s ‘money’ is the balance due to it from Bank 1, not the Central Bank QED ! – It’s more like ‘Fictional Reserve Banking’ than ‘Fractional Reserve Banking’. – This is what actually happens – if someone deposits a Bank 1 cheque in Bank 2 : Inter-Bank (Only between Bank 1 and Bank 2) owing and owed accounts are set up and Bank 2 has no idea what balances Bank 1 has with the Central Bank and does not particularly care – his £ 900 Asset is purely what Bank 1 owes him. Bank 1 still has the original £1,000 as a balance owing to it from the Central Bank. It might be objected that if it’s cash we are talking about then as cash has “The Bank of England owes this money” written all over every note, that it’s still ‘game on’ as far as the ‘Fractional Reserve story is concerned. Well no ! – Have a look at the Issue Department of the Bank of England . It shows that in Oct 2005 there was £36 Billion in Notes in issue, by Christmas 2005 it had risen to £39 Billion, it was back at £36 Billion in Feb 2006. Cash is a seasonally varying convenience for shoppers – it’s not the base of the economic system. Commercial banks ‘Order more cash’ at Christmas from the Bank of England because people like to walk in to pubs a Christmas with a few twenties on them to get in the rounds. Commercial Banks ‘Order more Cash’ simply by selling government bonds to the Bank of England and instead of using their Inter-Bank reserve accounts to pay for them. If, at a reserve ratio of 0.5% (or even worse for just paper cash, commercial banks issued loans when they had more cash and withdrew overdrafts and called in loans when they had less cash, then every day would be economic turmoil : “Quick someone has just withdrawn £100 from the ATM, we’d better call in £100/0.005 = £20,000 in loans to maintain our reserve ratio !” Also, when have you ever been into a bank to pay in your wages by cheque and had the bank clerk moan “Oh what a pity you are not paying this in cash – then we could loan it out and make a fortune – Cash is proper money, it’s so it’s much better for us to have cash in the bank than these silly cheque things, as we can loan out 10 times this cash but we can’t loan out 10 times this cheque.” Neither do they seek with special offers to attract teachers and other government workers to be account holders. Where have you seen : “Deposit your Bank of England pay cheques with us” – we want your ‘real’ Bank of England Money to loan out so we can make a fortune – such things do not happen – and this is because ‘Fractional Reserve Banking’ does not happen.

The World through the Bank Manger’s eyes

There are 4 major lines on a real Bank’s balance sheet : In the Assets section there is 1) Loans issued to Customers 2) Amounts owed by other Banks. In the liabilities section there is 3) Current Accounts (and other savings accounts) owed to customers 4) Amounts owed to other Banks. Its quite reasonable for a bank to never issue any loans as a policy, to only have current accounts and still make a nice profit – How ? Say Bank B had this policy. If Business X went to Bank A and got a Loan of £100, the entries in Bank A would be Dr Loan £100, Cr Current Account £100. The loan might make 10% interest and the Current account say 2%. So we start off with Bank A earning a Net of 8% and Bank B has nothing. If Business X pays a Worker W the £100 and the Worker W banks at bank B then the Worker W will deposit the salary cheque in Bank B. What happens then, in the behind the scenes Inter-Bank World, is that Bank B presents the cheque to Bank A and says ‘Here is an order signed by Business X requiring you to transfer the liability you owe to Business X to Worker W. But Worker W has told us to accept this liability so transfer the Liability you owe to Business B to us and we will make a note in our balance sheet that you owe us £100 and we in turn owe Worker W the £100’. The balance sheet of Bank B will then show Assets of only Inter-Bank Balances due to it from other banks, and its liabilities will be current accounts owed to customers. Bank B will then pay say 2% on its current accounts but will earn LIBOR (London Inter-Bank Offer Rate), which is usually higher than current account rates, on its Inter-Bank amounts owed balances – say 5%. So Bank A will earn 10% on the loan but will now pay 5% on Inter-bank Interest while Bank B will earn that 5% in Inter-Bank Interest from Bank A and have a 2% Interest charge on the Current account. (LIBOR is not an ‘official rate’ that will be charged, it’s just an average of Inter-Bank Rates, so a dodgy bank will have higher interest charges to pay on it’s inter-Bank balances than a ‘safe’ bank). In schedule form we have :

 

  Balance Interest % Rate Interest Balance Interest % Rate Interest
  Bank A Bank A Bank A Bank B Bank B Bank B
Loans to Customers – Assets 100 10 10      
Inter-Bank Balances – Assets       100 5 5
             
Inter-Bank Balances – Liabilities (100) 5 (5)      
Customer’s Current Accounts – Liabilities       (100) 2 (2)
Interest Profit     5     3

 In a similar manner a bank can have no current accounts and issue only loans – it’s liabilities will then be essentially inter-bank liabilities. Customers need nice high street branches (expensive rent) and lots of clerks and call centre workers (expensive) for them to sign up.

Bank Thinking – To loan or not to loan :

In the first instance, the bank manager will say ‘Yes’ to a loan very largely on the answer to the question – can you pay it back with interest. Other questions include : “Are you going to put any of my other paying customers out of business ? – i.e. will my loan of £500 for you to market your Free Energy machine mean my £ Multi-million loans to my oil customers might not get re-paid ? “What’s my policy ? – Am I an Agricultural Bank that specilses in loans to farmers and so maybe I have some expertise in better assessing a farm’s prospects. One thing is for certain, the “What ‘Real’ Central Bank Money do I have ?”, while being the big question Economists think is asked, is a total non-issue and just does not figure.

To foreclose or not to foreclose : When a customer is falling behind on loan repayments, banks foreclose and sell the security that backed the loan. What usually happens in such a situation is the house or business stock is sold quickly and hence cheaply as banks do not want the administrative expense of suddenly becoming a large landlord, which would happen if repossessed houses went on the market for 2 years to get their full price – not to mention the administrative expense of owning warehouses full of frozen chickens, ply wood, … whatever the security was. The bank usually makes a loss in such situations as it frequently does not receive enough from this fireside sale to repay the loan. Foreclosure for the bank is usually a cut-the-losses situation rather than a get the money all back. It also serves as a deterrent to other potential non-payers. This said I have heard of situations (see SAFE) where quite reasonable businesses were closed down by the bank calling in overdrafts suddenly and selling the business to friends and relatives of the bank manager for next to nothing, after which normal credit lines were resumed to the business under it’s new ownership – so abuses can happen, a bank manager can have lot of power and bank managers, despite forever being tagged ‘respectable’, are not exempt from Lords Acton’s ‘Power tends to corrupt and absolute tends to corrupt absolutely’ truism. Competition is the one of the best vanguards against such abuses and it’s worrying to see the re-monopolisation of high street banking since the Credit Crunch. Big Banks in the USA have been blamed for similar abuses on a huge scale in kicking off the Great Depression by hiking Inter-Bank rates to small banks which then either went bust or past these rates on to their customer’s who went bust. The big banks then were left holding a lot higher percentage of American Business afterwards.

What happens when a Bank’s customer goes bust : Stage 1) Bank issues loan of £1,000 to a Business A and Business A pays Workers £1,000 to make stock so we have :

 

  Bank 1 Business A Worker
Loans to Customers 1,000 0 0
Stock 0 1,000 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 (1,000) 0
Inter Bank Deposits 0 0 0
Wealth 0 0 (1,000)
Check 0 0 0

 

If say the Stock rots and drops to zero value, then the balance sheets look like this : 

  Bank 1 Business A Worker
Loans to Customers 1,000 0 0
Stock 0 0 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 (1,000) 0
Inter Bank Deposits 0 0 0
Wealth 0 1,000 (1,000)
Check 0 0 0

 So the Businessman, with a £1,000 Debit in his Wealth Account goes bankrupt and the bank gets nothing from the sales of the rotton stock and will get nothing back from the loan, so it writes it down to Zero and we have this :

 

  Bank 1 Business A Worker
Loans to Customers 0 0 0
Stock 0 0 0
Current Accounts Owned 0 0 1,000
Current Accounts Owed (1,000) 0 0
Loan Owed 0 0 0
Inter Bank Deposits 0 0 0
Wealth 1,000 0 (1,000)
Check 0 0 0

 And so the Bank 1 now has a Debit in it’s Wealth Account of £1,000 and is insolvent and needs, by law to close down. Had the worker deposited the money in a Bank 2 then after Bank 1 closed down then Bank 2 would have to write off it’s Asset “inter-Bank Balance due from Bank 1” down to Zero we would have had this situation :

 

  Bank 1 Bank 2 Business A Worker
Loans to Customers 0 0 0 0
Stock 0 0 0 0
Inter Bank Owed 0 0 0 0
Current Accounts Owned 0 0 0 1,000
Current Accounts Owed 0 (1,000) 0 0
Loan Owed 0 0 0 0
Inter Bank Deposits 0 0 0 0
Wealth 0 1,000 0 (1,000)
Check 0 0 0 0

 and now Bank 2 has the £1,000 Debit in it’s Wealth account and now it’s insolvent – this happens in a chain. So banks need to be careful in who they loan to – not just to Business and Individuals but to other banks as well. They don’t worry about how much Bank of England money they have, they worry if their customers will pay; and if not, what the security is worth – again no Fractional Reserve.

“We Don’t Create Money !” – If you asked a building society manager in recent years “Do you create money when you issue a new Mortgage ? – Dr Loan/Mortgage £200,000, Cr Current Account £200,000” they’ll say “No – we don’t do that. The reason why we don’t do this is, if we have the mortgage at a nice small 5%, then those current accounts we necessarily create at the same time will be used to give to the people our customers are buying the house from and they won’t sit around as a 2% current account liability in our accounts, they will turn up in the current accounts of other banks and we will be LIBORed with Inter-Bank balances at near and maybe even over 5%. So what we do is we go out and we ‘get cheap money from the ‘wholesale markets’ by selling short term Mortgage bonds, it’s this money we lend out as mortgages – so we don’t create money, we are just agents lending out other peoples’ money – the money of the bond buyers. Our double entry to ‘get the money’ is i) Dr Inter-Bank amounts Owed £200,000 (That’s what a banker calls ‘having money’), Cr Money owed to Wholesale markets (Mortgage Bonds) £200,000. When we issue a mortgage to a house buyer, we do ii) Dr Mortgage Account Asset £200,000, Cr Current Accounts £200,000 but the moment that the ‘money’ – the Current Account – passes to the house seller and appears the next day as an inter-bank liability, then we net-off these Inter-Bank Liabilities with the Inter-Bank amounts Owed Assets from i) “

To “get cheap money from the ‘wholesale markets’ by selling short term Mortgage bonds” in more detail – The building societies type on a piece of paper “I will pay £200,000 plus interest of 3% per annum in three months to the bearer. This is a type of Commercial Paper called a Mortgage Backed Security. These are then sold to the Wholesale market for hopefully £200,000 + interest. (by ‘sold’, I mean the Building Society receives Inter-Bank balances owed as payment). 

Who bought this Commercial Paper ?, If money was not created at the point of issuing the mortgage to the house buyer, was money created at the point of selling the Commercial Paper ? If a pension company, an insurance company or rich individuals bought the Commercial Paper, then no new money was created, If a bank bought it then this does create new money (when bank buys anything it buys it with new money ! – it can’t help it ! – If a bank buys a building the entries are Dr Fixed Assets £1,000,000, Cr Current Account of building seller £1,000,000 – this is new money !) Also, if a bank made a loan to a some sort of Investment Company which then bought the Commercial Paper then new money is created at the moment the loan is made, though this money does not ‘hit the streets’ till the house seller receives the payment. So though the building society manager was right when he said “We don’t create money”, given that we now know that lots of banks lost lots of money in the housing sub-prime crash, that banks were involved, either buying this Commercial Paper directly or else making loans to companies that did, so this means that a lot of new money was created in the fuller picture of the issuing of the mortgages. 

The ‘fuller picture’ in detail : a) A Bank creates loan for an Investment Company : Dr Loan to Investment Company £200,000, Cr Current Account of Investment Company £200,000 (New money created here)

 b) The Investment Company buys Commercial Mortgage paper : Dr Commercial Paper assets £200,000 Cr Building Society £200,000

c) The Building Society issues a New Mortgage : Dr Mortgate Account £200,000 Cr Current Account of Mortgagee £200,000. The Mortgagee then ‘pays money’ to the house seller/builder and this party deposits the building society cheque in their bank account so we have essentially this can be shown in one step :

c’) Dr Mortgage £200,000, Cr Inter-Bank Liabilities £200,000 – Building society entries and Dr Inter-Bank Assets £200,000, Cr Sellers current account £200,000 – Entries for the bank account of seller – this is the point that New money created by the bank issuing the loan to the Investment Company fund in a) ‘hit’s the streets’ and is new money in Joe Bloggs bank account – (ready so spend on Chinese imports).

As a tidy-up, the Building Society that has assets of £200,000 inter-bank money owed and £200,000 Inter-Bank money owing nets them off.

I don’t fully know who bought what Commercial Paper and I’m not sure if anyone does, there was lots of off-balance sheet, off-shore stuff involved. A major purchaser of this Commercial Paper seems to have been the Chinese. China has a Net-Export policy – it sells to us but does not buy from us, this is a deliberate policy that has devastated our industrial base – far better than their air force could have. When it sells to us, say a pair of shoes, we give China £20. As China does not use this £20 to buy our goods, it instead buys our Commercial Paper – effectively our mortgages so we give China £20 for some shoes and the £20 re-appears the next day as loan to us so we can buy our houses at ever higher prices. So as well as wrecking our industrial base it has also helped create a huge mortgage bubble which has now burst and brought the West to its financial knees… and there is more to come – many American mortgages are still on their initial period ‘teaser rates’; there are quite a few mortgages that will switch to the ‘normal rate’ in the shortness of time… tick tick tick).

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